“How successful are our investments?” “Oops, sorry, dear. I don’t know.”
How do you keep score of your investment success?
Whether you invest in an industry super fund; a corporate super fund; with a stock broker; in an investment property or anything else, you need to know how successful your decision has been.
You need to measure your performance and compare it to what you are trying to achieve, i.e. your objective.
And a smart investment objective is one that has distilled the aspiration, as it were, down to a metric. That is, an objective that is readily measurable.
1. Don’t confuse profit with rate of return: use % p.a.
Many investors speak in terms of the profit they made on a transaction.
For example, you pay $1m to buy a residential investment property and after 10 years you sell it for $1.8m. (You also rent it out for $770 per week, but we’ll come to that later).
You have made $800,000. An 80% return. Or have you?
What seems like a massive profit is not so great on a % p.a. basis
|Annualised return||6.1% p.a.|
No. Because the profit gained was made over a long period of time, the actual gain each year is only a modest 6.1%.
You need to measure on an annualised basis, so that you can compare your success with your objective and with alternatives you might have available.
2. Don’t forget to deduct all costs
Most people just add the revenue and forget the costs. But there are costs in every type of investing. Investing in shares has brokerage, custody and other administration costs while even some bank saving accounts have fees.
And, in our property example, the 6.1% p.a. capital return is sharply reduced by stamp duty and transfer costs on purchase, and selling expenses, bringing this down to 5.2% p.a.
The income return (i.e. rental yield) of 4% p.a. on purchase price is an actual 3.8% p.a. on purchase cost. This reduces further with running expenses to about 3.3% p.a.
So a seeming total return of 10.1% p.a. is reduced to 8.5% p.a. 
This is the same with all types of investment. In calculating your success you must take into consideration all costs, as well as all revenue.
3. Don’t forget the cost of advice
You might engage a financial planner or other adviser to give you guidance or advice. The cost of the advice is part of the cost of investment.
For example, many planners charge an annual fee for advice, that ranges from 0.4% to 1.1%. This is a cost that must be deducted from the annual investment return.
So, if your “wrap platform” (the administration system that packages up investment choices) gives you a return of, say, 8.5% and your planner is charging you 0.75%, then your net return is reduced to 7.75%.
4. Don’t forget tax
The death hand of the Australian Tax Office is everywhere.
In measuring your success, you must consider tax, because what the ATO takes, you don’t have.
And remember to compare: different investments have different tax arrangements (e.g. you don’t get franking credits with a property investment).
5. What about the effect of inflation?
Inflation affects all asset classes equally.
So, in planning your fiscal needs in retirement, the key is how much your income can buy in the future. With a CPI of 3%, $100 today is worth only $65 in 10 years time.
Summary – what does a good investment objective look like?
The investment objectives used by some First Samuel clients, and therefore a measure of success, covers all of the above. For example:
“to outperform CPI by 5% p.a. after all expenses and tax benefits , measured quarterly over rolling 5 year periods.”
And we incorporate our advisory costs in our performance returns. If we followed industry practice, our performance would be some 0.5% p.a. higher than we report.
Talk to experts about this. Talk to First Samuel. It doesn’t quite work out exactly like this, for a variety of mathematical reasons.
 This refers to franking credits. But when we report to individual clients, we incorporate an estimate of their tax liability in measuring performance.